Country Report Uruguay
With general elections scheduled in October, 2014 will be an important election year for Uruguay. Meanwhile, several important investment projects have become controversial.
Strengths (+) and weaknesses (-)
+ Strong institutions
Uruguay’s public institutions are relatively strong. The country, for example, has a much lower level of corruption than its direct neighbours.
+ High planned investments will boost near-term growth
Foreign direct investment is expected to remain high, which will boost near-term growth and strongly mitigates balance of payments risk.
- High level of dollarization
The financial system still has a sizeable degree of dollarization. A substantial part of the government debt is also denominated in foreign currency.
- Vulnerability to external shocks
Uruguay is vulnerable to agricultural commodity price shocks and a deterioration of the economic situation in Argentina. Argentineans account for 60% of all tourists, while tourism accounts for 6% of GDP.
1. 2014 election year
2014 will be an important election year for Uruguay, as general elections will take place in October 2014. A new government will take power in March 2015. Since 2010, José Mujica has been Uruguay’s president. Mujica was the candidate of the Frente Amplio (Broad Front), a center-left coalition that has ruled Uruguay since 2004, when it broke the hold of Uruguay’s two conservative parties on power. Fears that Mujica would implement radical policies, given his affinity with more left-wing forces within his coalition, have not been justified so far. Instead, the present Frente Amplio government has continued to follow a moderate economic policy course. This government received international attention when Uruguay, as the first country in the world, legalized the cultivation, sale and consumption of marijuana in December 2013. Looking forward, Tabaré Vázquez, who was already Uruguay’s president between 2005 and 2009, is likely to be the Frente Amplio candidate at the general elections in 2014 (Mujica is not allowed to run this year, as Uruguay’s constitution does not allow consecutive terms for presidents). Constanza Moreira, a senator belonging to a more radical left-wing party in the Frente coalition, will be the opponent of Vázquez for the presidential candidacy of the Frente Amplio at the June 2014 primary elections. Though she is very unlikely to win, if she does well, she may press the Frente to follow a more left-wing course. The latter may reduce the appeal of the Frente to more centrist voters. Nevertheless, the Frente Amplio is the favorite block to win the October general elections.
2. Criticism of mega-investment projects has been growing
In the past decade, the Uruguayan economy has become more diversified. Traditionally, the economy relied on beef exports, financial services and tourism. However, in the past decade, the grain, dairy, pulp and transportation and logistics sectors have become important new economic sectors. In particular the dairy and pulp sectors benefitted from strong foreign investments. A number of planned mega-investment projects in the mining and transportation sectors may help to diversify the economy further. The most important is the Aratirí project, an iron ore extraction project proposed by an Indian company. According to the company, this USD 3bn project would create USD 1.4bn in annual exports during its 20-year lifespan and create significant employment and fiscal revenues. Related to this project is a planned USD 1bn investment in a deep water mega-port facility in the eastern province of Rocha. Besides, there are also plans to build a large liquefied natural gas import terminal. However, environmental criticism of all these three projects has grown strongly in recent months. In particular the mining project might be vulnerable, as environmental groups, supported by at least one opposition party, are trying to organize a referendum in which the population could vote to ban mega-mining projects. A cancellation of the mining project might also threaten the viability of the deep water port project. So far, the government has continued to support the projects, with President Mujica strongly criticizing the protesters. Nevertheless, there is a chance that projects will not materialize, which could negatively affect investment and growth in the coming years.
3. Inflation remains high, while peso has come under downward pressure
Inflation has remained relatively high in Uruguay. While the country has a inflation target range of 3-7%, inflation is estimated to have remained above 8% for a third year on a row in 2013. Inflation is expected to fall in the coming years, partially as fiscal and monetary policy are tightened. However, the fall is likely to be slow, as the labour market has remained tight and wage indexation remains very common. Meanwhile, the Uruguayan peso came under strong downward pressure when the US Federal Reserve indicated in May 2013 that it would soon start to taper its special asset purchasing programs. The peso has appreciated somewhat since September, but remained about 11% below its May levels against the USD in late December. At first sight, Uruguay may look vulnerable through its large current account deficit (see also figure 2), but this deficit is matched by high levels of foreign direct investment (FDI). In fact, at 5.2% of GDP, net FDI is estimated to have continued to exceed the current account deficit in 2013. As Uruguay has a sizeable foreign reserves stock of almost 13 months of imports, overall balance of payments risk remains acceptable.
With an estimated per capita income of USD 16,380 in 2013, Uruguay is one of the richer countries of Latin America. Uruguay’s population and its economy are relatively small. The country has relatively good public institutions. For example, according to the Corruption Perception Index of Transparency International, it is the least corrupt country of Latin America. Income inequality, though substantial, is low by Latin American standards, and Uruguay’s politics are relatively consensual. The country has democratized successfully after a 12-year period of military rule ended in 1985.
Due to close financial, trade and tourism links with Argentina, Uruguay was severely hit by the 2001/2002 economic crisis in Argentina and in 2003, the country had to restructure its sovereign debt. Afterwards, its dependence on Argentina has decreased, though the tourism sector, which accounts for 6% of GDP, is still very dependent on Argentina. 60% of visiting tourists come from Uruguay’s South-western neighbour. Uruguay’s exports predominantly exist of agricultural products, in particular livestock/beef, agriculture and dairy products. Other important economic sectors are the financial sector and tourism sector. A high level of (foreign direct) investment has diversified the economy and is expected to continue to do so in the near future. The high level of foreign direct investment is an important risk mitigant for the relatively high current account deficit.